Bridge loans are short-term loans with high-interest rates until a company secures permanent financing.
Brad Nakase, Attorney
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When it comes to bridge loans, the application, approval, and funding process is much faster than that of traditional loans. Because of the quicker turnaround time, a business can get the funding it needs to buy equipment, stock inventory, or manage payroll quickly. Bridge financing is important for business owners who need to finish a job or are attempting to place a bid on additional projects. A business owner may be looking to purchase real estate or buy another business; regardless, bridge financing gives the business owner an advantage over other bidders because the owner can close the deal faster.
It is typical for business owners who are short on cash to look at short-term financing through an equity partner. That said, part of the deal generally involves their partner getting a greater stake in the business. Bridge loans are a sort-term financing solution, so a business owner will not need to turn to his or her partner for help. Also, a business owner can keep control of his or her business, so this type of loan works in his or her favor.
As a small business attorney in San Diego, I see that the second most common reason for a startup’s failure is problems with cash flow. This can be an issue for a business owner who may be running a financially sound business, but still falls victim to running out of money. When an otherwise healthy business has a cash flow problem, it is often the result of long payment cycles. For instance, if a business owner operates a construction business, he or she may get paid at the start and end of a project. During the interim, the owner will still need money to finish the project and afford other expenses. Bridge financing is a potential solution to this problem. It offers access to cash to cover upfront expenses while waiting for payment.
In general, the terms of bridge loans range from three to eighteen months. Because of this, a business owner will have to make larger monthly payments than he or she would for traditional loans. If a business has plenty of money to make the payments, then this is only a minor inconvenience. That said, if a business is late making payments, then there can be costly penalties and interest.
If a business owner has taken out a bridge loan, then he or she may be expecting to receive payment in the future, especially if he or she is about to finish a project. But if a business owner plans to use the money from the anticipated payment, then the payment falls through, this can create a big expense. This may also mean that the business owner will be left with significant debt to income ratios, which makes it hard to run a successful business.
That said, this is a rare scenario. U.S. News reports that less than one or two percent of bridge loans run into this kind of issue. But every loan involves risk, so a business owner should consider every possible complication.
Because bridge financing is designed to be a short-term loan, a business owner will not be paying interest for as long a period as a traditional loan would demand. Therefore, to compensate for this, some lenders will charge a high rate of interest on bridge loans. This means that a business owner may pay less interest overall for a bridge loan, but at a higher rate.
Lenders may also charge extra fees on bridge loans, which may include origination fees and closing costs.
The theory behind bridge financing is simple enough, but it is important to understand when and how best to use this type of loan. Prior to deciding on bridge financing, a business owner should consider the above list of advantages and disadvantages to see if it fits their business’ needs.
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